Taking charge of your own finances

Retirement will be no fun without enough money to enjoy it. Unfortunately most of us are being kicked out of our company's defined benefit funds, can't rely too much on the government for help, don't understand the defined contribution funds we've been put into and are not saving enough anyway. To make matters worse we are being ripped off by a savings and retirement industry that is skimming of the top of our investment returns while giving us very little good advice or value.This blog contains some of my thoughts on taking control of retirement and pension savings. It will look at ways of cutting costs by using cheap online stockbrokers and share dealing combined with cheap index funds and Exchange Traded Funds (ETFs) to build diversified portfolios. This is a work in progress so I welcome your thoughts.

Monday, December 14, 2009

Investor interest in bullion has soared over the past few years with many savers who are worried about inflation looking into how they can invest in gold and whether ETFs (Exchange Traded Funds) are the best way of getting exposure to the precious metal.

Gold as an inflation hedge
Before even considering an investment in gold you need to look closely at the rest of your portfolio of assets. Bullion's traditional role has been to protect against inflation based on the idea that because it is scarce and you can't print more of it at will, that it will hold its value even if paper money doesn't. Yet it hasn't really done a great job at that. People owning bullion would have done fine through the 1970s to gold's peak in 1980 but would then have taken a bath. for almost two decades. It is only really since 2007 that gold has spiked up in nominal terms (not adjusted for inflation).People holding it will have incurred huge cost over the years with very little to show for it over most of that period.
The first is that although gold can hold its value against paper money, it is also an asset that doesn't produce returns. If you have gold just sitting in a vault you have to also figure out the opportunity cost of holding it. At the very least you could be getting a couple of percentage points a year return from investing in government bonds or treasury bills. Over most periods cash, bonds or shares will have done better than gold, even if they are a bit riskier.

Gold as catastrophe insurance

Another role that bullion plays is as a safeguard against turmoil in the financial system. Many bugs call it the ultimate assets because unlike, say, a government bond, no-one owes you anything so nobody can default. That may well be true, but it is worthless having the only assets left worth anything if everything else has devalued completely. If you really anticipate a complete breakdown of all society then you're probably better off investing in shotgun shells, as there will be a ready market for those as well as ready need if you have to defend your hoard.

Even so, worries about turmoil in the financial system and about inflation rising again have clearly played their part in gold's big run in late 2009. Now plenty of people have argued that this is just the start and we are seeing predictions of gold hitting $2000 in not too long. But most pundits have short memories. I was covering the gold markets in the late 1990s and early 2000s when central banks were tripping over one another to sell and the price had to be artificially supported by an agreement not to sell too much at once.
I'm not going to completely stick my neck out with forecasts, but I'd be inclined to think that over time the price of bullion will be lower rather than higher. The Economist magazine's Buttonwood columnist recently ran a post quoting a really interesting figure suggesting just how overvalued gold has become. The figures from Tim Lee of pi Economics show that:

*On average, it has taken 400 ounces of gold to buy the median new home. Now it takes 185.

Houses and mortgages as inflation hedges
That figure is really interesting. What it suggests to me is that gold should be thought of as just another currency which has appreciated against the dollar and which in turn has been outpaced by the growth of bubbles in other assets such as houses. It is not to say that gold won't be the next bubble and won't rise further. But it is to say that buying gold is far more like speculating on a currency than it is about hedging against inflation.
The more important point is that many people are naturally hedged against inflation if they have bought a house (which over time should rise in line with other prices) and have a mortgage. If you have then the loan you used to buy your house is falling in value during times of inflation while your house is rising. There is then little need for extra protection.
If you have paid off your house and retired then the case for buying protection is greater, but I would think it could be achieved far better through buying inflation-linked bonds (I'll have more on these in a later post).

Investing in gold ETFs
If you're still with me after all these reasons not to buy gold you must be pretty persistent. Have you thought hard about whether it is right for you?

Okay then.

There are three main ways of investing in gold. The first is to buy coins and hide them under your bed or, if you're rich enough, bullion bars and paying your bank to look after them. I guess that if it is catastrophe insurance you want (and you already have your cans of beans and shotgun shells) then this is the way to go.
The second way is to hand your money over to one of several bullion vaults that have jumped up in recent years. Think of these as the bank deposits of gold. You buy an amount, usually paying by the gram and they mark up "your gold" in their vault. You can trade it at any time and they charge you a spread between the selling and buying price as well as a fee for looking after your gold. You can't touch or feel it and have to trust it is there.
The third way is to buy a gold exchange traded fund such as the SPDR Gold Trust ETF or iShares COMEX Gold Trust. These are, as the name says, funds that trade like shares. The advantages of this approach is that you are buying a security that is transparently traded on an exchange in an open market so the spreads (between the price for buying and selling) will be competitive.If you use on online stockbroker for your share trading you shouldn't pay too much in commission. The rules that govern ETFs are also pretty strict. so you need not worry about whether your gold will still be there in the morning (what it will be worth is a different question entirely). This is because the gold is held in a trust structures that keep assets separate from the companies that manage them. Even if iShares or State Street Global Advisors, which manages the SPDR funds, were to go bust, their clients need not worry. The gold in the trusts is allocated to them and kept safe.
The management costs are also reasonably competitive and are usually about 0.4% of the value of the assets in the fund.
I'll look at some of the funds in more detail in a later post including how much each one charges and also whether they use derivatives to get exposure (and thus incur a risk that their counter-party may go bust).
For now I'm afraid to say that at current prices I won't be joining you if you do, but if you insist on buying bullion I hope this guide on how to invest in gold ETFs has been helpful.

Friday, December 11, 2009

The debate about whether transfer incentives being offered to encourage members to leave defined benefit pension plans are a scam has become even more heated in recent days. This has long been an issue that has worried the regulator. It again sounded a warning on the subject saying there was evidence that high pressure tactics being used to encourage members to quit the relative-security of defined benefit plans and to move over to defined contribution plans, where most of the risk is transferred from the company to the employee.
A good article by the Telegraph newspaper after the regulator's warning over pension sweetners points out that in many cases employees are offered a cash payment instead of an "enhanced" payment into a new retirement plan. The danger of handing over cash is that:

this could be spent now, at the expense of the client's future pension," said Lee Smythe, adviser at Killik & Co.

The article also quotes Paul McGlone, Principal and Actuary, Aon Consulting saying that the regulator is 'scaremongering':

“While we agree that such exercises must be properly conducted, the fact that some bad examples exist doesn't mean that they should all be tarred with the same brush.
"There are many examples of well run exercises, and it's not for the Regulator to determine what is or isn't in a member's interest - that is for them and their IFA. By making comments such as this the Regulator is just adding to the fear that ordinary people have about pensions."

As a board-certified scaremonger myself, I'm afraid I can't quite bring myself to agree with Mr McGlone. Would it, in fact, be too cynical to wonder whether he has done some consulting for some of the companies offering incentives to get employees to leave their defined benefit funds?. That may be too uncharitable of me. But either way I have to agree with the regulator's starting point, which is that it presumes these are not in the interests of members of the pension funds and that it is for the company to prove otherwise. That seems to make far more sense than for the regulator to stand back completely, as Mr Glone suggests, and expect every single member to get good independent advice from a financial advisor.
I don't have the luxury of being in a defined benefit plan - my current employer closed it to new members a few years before I joined - but if I was in one the offer to get me to even think about leaving it would have to be more than generous. As I mentioned in a previous post on why leaving defined benefit plans is generally a bad idea, buying the sorts of guarantees that go into a pension for life are expensive, and likely to become even more expensive with time. I'm not sure that I would consider the sweeteners of the order of 25% such as those apparently offered by Intercontinental Hotels to be enough compensation for taking on much more risk.

Thursday, December 10, 2009

Probably the most important decision towards trying to take control of your retirement is to start saving sooner rather than later. Here's a link to a piece I wrote on a different forum about how compounding returns mean that the sooner you start saving, the less you will have to put aside. You can read it at: Retirement made easy: How soon should I start saving?

In the last couple of years the experience of those saving for pensions and retirements have been polarized into two distinct worlds: those with Defined Benefit plans (DB) and those in Defined Contribution plans (DC).Investment risk
Both have their advantages and drawbacks but the main difference between the two is that people in DC plans have no guarantees of anything. In a DC plan you and your employer contribute set amounts to your pension pot every month and what happens to that pot is your problem and yours alone. You may invest it all in cash and earn a return so paltry that you struggle to have enough money to retire. Or you may invest it all in shares taking a gamble that you will either hit the jackpot and be made for life or perhaps end up trying to retire on less than you saved in the first place. There are a million variations in between, but in short, what happens with your pot of money is in your hands and you have to live with the consequences.

In a Defined Benefit plan, the company takes that investment risk. It promises to pay you a retirement, and how it gets there is its problem. This is not entirely risk free for a saver as you have to worry about the company going bust, but in general the certainty that a DB plan gives is worth a lot. One measure of this is the price that companies have to pay insurers to take over their DB plans. Before life insurance companies will agree to promise to pay retirees the same pension that they are already getting from companies, they will typically ask for a premium of up to 30% to the assets in the existing fund. In other words the certainty that is offered by having your payments guaranteed (and not subject to the fluctuations of the market) is worth at least 30% of your assets. And that assumes you are already retired.
Trying to buy a similar annuity from a life insurer while you are still working is almost impossible because few insurers will want to take on the risk of what might happen to stock and bond markets 30-40 years from now.

Longevity risk
Another risk that has to be taken into account is the question of how long you will live. A long, healthy life should be a blessing. But if you are in a defined contribution fund there is nothing to protect your savings from the fact that the longer you live in retirement, the more money you will need to avoid running out of catnip. This doesn't just affect retirees. Although I'm in my late 30s, the average life expectancy of people retiring now is increasing by as much as a few months every year. By the time I hit retirement age I can, with luck (and on average) look forward to many years of walking the dog. The downside is that by the time I get to that age, the price of buying an annuity with my savings will have increased to reflect that.
Employees in DB funds don't have to worry about such things. Rising longevity is a problem for the fund and their employer, which has to top up the retirement fund if it starts running short of money.. So it is not surprising that most big companies have now closed their DB plans to new members and are also trying to get existing members of these plans to switch out. The way they are doing it is by offering incentives.

The transfer incentive scam
All of which brings me to a talk by David Norgrove, the chairman of Britain's official Pensions Regulator on transfer incentives being offered by companies and some of the "worrying tactics" they are using to encourage people to leave Defined Benefit plans. These include putting excessive pressure on people (calling and coming to their houses), misinforming them by suggesting the DB fund is not safe and using high pressure sales tactics such as telling them they only have a limited time to act. But that trustees of pension funds should:

...start from the presumption that such exercises and transfers are not in member interests.

Many members are likely to be strongly influenced in their decision to transfer by the immediate prospect of receiving an attractive amount of cash - or by an offer which contrasts an 'enhanced' transfer value with a pension from an under-funded scheme.

...If a company is willing to encourage the transfer, the company's gain is likely to be the member's loss.

In other words "if they want me to have it, then I probably don't" - which would seem to be a fair starting point for skeptically assessing all offers in the snake oil world of savings, investment and retirement.